Protocol Ratified to the Russia-Cyprus Double Tax Treaty.
Legal Update No. 333
Goltsblat BLP advises that Federal Law No. 9-FZ “On Ratifying the Protocol Amending the Agreement between the Government of the Republic of Cyprus and the Government of the Russian Federation for the Avoidance of Double Taxation with Respect to Taxes on Income and on Capital dated 5 December 1998” was adopted on 28 February 2012.
The Protocol constitutes an integral part of the Agreement, will come into force on the date of the last of the notifications on completion of relevant intra-state procedures and will apply from the beginning of the subsequent calendar year. On completion of the procedures, the Protocol is expected to become effective on 1 January 2013.
Here are some of the essential novelties contained in the Protocol:
1. Tax to be charged on sale of shares with more than 50% of the assets in real estate
Income from sale of shares in companies deriving more than 50% of their value from immovable property may be subject to withholding tax at source. This rule does not apply to income from shares obtained as part of a corporate reorganisation or those quoted on a registered stock exchanges or where the income is earned by a pension fund, a provident fund or the government of a party state. The provision becomes applicable from the beginning of the year following the expiration of the period of four years from the Protocol’s effective date, i.e., not earlier than 2017. Please note that, if interpreted formally, this provision may be applicable to sale of shares and ownership interests both in Russian and foreign businesses.
2. Application of Thin Capitalisation Rules is Permitted
Dividends are now understood to include income taxable in the same manner as income from shares in compliance with the legislation of the state in which the payee resides, even if it is paid in the form of interest. At the same time, this type of dividend is excluded from the definition of interest. These changes enable direct application of Article 269(2) of the Russian Tax Code on re-classification of controlled interest debt payments into dividends. In view of the position adopted by the Russian Supreme Arbitration Court on the possible application of thin capitalisation rules irrespective of the provisions of non-discrimination tax arrangements (as expressed in Resolution of the Presidium of the Russian SAC No. 8654/11 dated 15 November 2011 in the Severny Kuzbass case), it is reasonable to anticipate that, once the amendments to the Agreement become effective, will reinforce the tax authorities’ desire to raise the relevant tax claims upon reclassification of interest as dividends for the purposes of taxing payments at source.
3. Withholding tax also applies to income from unit funds and investment in real estate
The Protocol provides that income gained from REITs or similar collective investment schemes set up primarily for investment in realty is to be taxed at source as income from real estate. It also specifies that gains from shares in unit investment trusts or similar collective investment schemes, other than the payments set out in clause 6, Income from Immovable Property, are considered to be dividends.
4. Wider opportunities for sharing information and cooperating in tax collection
New versions of Articles 26, Exchange of Information, and 27, Assistance in Collection, have been adopted considerably extending the opportunities Russia and Cyprus have for sharing information and collecting taxes. Please note that article 27 will come into effect once Cyprus adopts the relevant legislation. These changes are in accord with the OECD Model Tax Convention on Income and on Capital. Information sharing and assistance in tax collection opportunities (including interim relief measures) are envisaged for the taxes discussed by the Agreement, as well as any other taxes adopted on behalf of a party state, unless they run counter to the Agreement. It is established, however, that a party may refuse to provide the requested information if this involves disclosing any commercial, business, industrial or professional secrets or trade processes, or disclosure of which would be contrary to public policy (ordre public) or that is unobtainable by virtue of law or in the course of the usual administrative practice of the contracting state.
5. The minimum investment qualifying for a beneficial dividend tax rate is raised to EUR 100,000
It is established that the reduced 5% dividend tax rate will apply if the person enjoying the actual right to dividends has invested directly at least EUR 100,000 or the equivalent (previously USD 100,000).
6. Determining the place of effective management
Article 4 of the Agreement about determining the place of residence now specifies that if it is impossible to determine the place of effective management of a person (other than an individual), the competent authorities of the party states will seek to determine the place of effective management in each specific case by mutual agreement, in consideration of all the factors they believe to be relevant.
7. Refusal to grant benefits enabled
A new provision is added to the effect that if, following consultations, the parties conclude that a resident entity has been set up for the primary objective of obtaining benefits under the Agreement, they may refuse to grant the benefits. Please note that, under the Protocol, this provision will only apply to companies not registered in a party state, i.e., it does not cover companies incorporated in Russia or Cyprus. If interpreted formally, this provision is intended for companies not registered in Cyprus that are Cyprus residents (for instance, due to having their place of management in Cyprus). The practice has never been extensively used with regard to income originating from Russia, so we anticipate that this novelty will be of limited practical significance.
In addition, in light of the recent discussion regarding withholding tax on Eurobond payments for the benefit of SPVs, which the Russian Ministry of Finance believes may not be considered as actual recipients of income (Letter of the Russian Ministry of Finance No. 03-08-13/1 dated 30 December 2011), it may be reasonably expected that Russian tax authorities will approach the issue of whether benefits envisaged by the Agreement might be applied more carefully.
8. New permanent establishment criterion in the event of services rendered via individuals
Permanent establishment criteria for tax purposes have been specified for situations when services are rendered in the other party state through an individual other than an agent, broker or other person acting independently. Under the new rules, a permanent establishment exists if services are rendered:
through an individual located in the other state for more than 183 days in aggregate within any 12-month period and, during this time, the services rendered in this state via the individual account for more than 50% of the entity’s total income from active operations, or
for a total of 183 days in any 12-month period as part of a single project or a number of interrelated projects by one or several individuals who are present and render the services in the other state.
Services rendered by an individual on behalf of an entity are not deemed rendered through the individual by another entity unless the other entity is supervising, managing and controlling the method by which the individual renders the services.
These rules will supposedly be used by Russian tax authorities to prove the emergence in Russia of a permanent establishment of Cyprus companies that, in the opinion of the supervisory authorities, are actually managed from Russia. To minimise tax risks, these rules will need to be taken into account in structuring management and operations of Cyprus holding companies with business relating to Russian assets.
9. Other amendments
Other amendments introduced by the Protocol include the criterion of the place of effective management for taxation of international carriage and other changes bringing the Agreement closer to the OECD Model Tax Convention.
For additional information, please contact:
to Evgeniy Timofeev
Partner, Head of Tax Practice for Russia/CIS,
T: +7 (495) 287 44 44,
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